Diversifying globally may balance out your portfolio
Eating hamburgers and fries every day can get boring (and unhealthy). That’s why it’s important to step outside your comfort zone and treat yourself to some international cuisine every once in a while. I’ll take a spicy tuna roll, please!
When diversifying your portfolio, it can also be important to think globally. By including international investments, you increase your investment options while balancing out the risk and return of domestic stocks and bonds.
International developed markets provide some stability for investors
It’s tough to go abroad and feel like you don’t have the same comforts of home. No, I don’t mean your big comfy bed; I mean things like a stable economy and political system.
If you’re nervous about investing outside of your domestic market, an easy first step to global diversification is investing in international developed markets. These markets usually consist of the stocks of companies based in large, vibrant countries with strong or stable economies.
Unlike international emerging markets, which are still catching up in terms of monetary policy and rule of law and can, therefore, be relatively risky for investors, international developed markets usually have stable economies and political systems (similar to the stability found on your home turf). This makes international developed markets attractive to some investors, even if they have less experience investing outside of US stocks.
Investing internationally may limit portfolio volatility
Many of the most successful companies in the world are based in developed regions such as the UK, Europe (Germany, France, etc.), Japan, and elsewhere. Some well-known companies like Nestle, Toyota, and even Budweiser are located in these regions.
By investing in the stocks of these international developed markets, you can balance out risks you may face in other parts of the world. For example, political events that affect US markets may not affect European or Asian markets. It’s also possible that during certain periods, international markets could be growing or expanding while US markets may be fluctuating or decreasing. That’s why holding the stocks of many regions can help to minimize portfolio volatility.
Use benchmarks to track international markets
Just like the S&P 500 and Dow Jones Industrial Average (DJIA) track major US stocks, there are indexes that track international developed markets as well. One such index is the MSCI Europe, Australasia, and Far East Index (EAFE), which includes Europe, Japan, and other developed regions. There are also indexes that track individual regions and countries, such as MSCI Europe or MSCI Japan.
Nearly all developed countries also have their own indexes. For example, many investors look to the Financial Times Stock Exchange 100 Index (FTSE 100) for stocks on the London Stock Exchange or the DAX, which consists of 30 major German stocks. While you can’t directly invest in these indexes, there are almost always mutual funds and exchange-traded funds (ETFs) that track these benchmarks.
International markets provide another level of diversification
Why should you include developed international stocks in your portfolio? Simply put, they can add an attractive level of diversification when combined with US stocks, and they could also present additional opportunities for growth under certain market conditions. Take a look at the numbers in the below chart.
Chart: Earnings-per-share growth (bars, left axis) and P/E ratios (diamonds, right axis) across region
Source: Clearnomics, MSCI, Thomson Reuters
The chart shows that international developed market stocks are attractive based on a number of investment metrics. The height of the bars reflects the profitability of companies in each region. It’s easy to see that, at the moment, emerging market companies (orange) can be some of the most profitable in the world, on par with US large cap companies.
Additionally, the diamonds show each region’s price-to-earnings ratio – a metric that measures whether an investment is expensive or cheap relative to the earnings of its underlying companies. Currently, emerging markets as a whole are the most inexpensively valued region in the world when compared to the prices of stocks with similar earnings in other regions.
Similarly, stocks in developed countries outside of the US can offer you access to potentially inexpensive investments when compared to how much those companies can grow versus companies in the United States (depending on market conditions).
International investments provide you with more options
You really have no shortage of options when choosing how to invest in developed international markets. The most important step is to consider moving beyond your domestic market by becoming educated in how international markets can potentially help balance out your portfolio.